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August 21, 2014

China Antitrust Enforcement Harms Multinationals

In a recent spate of antitrust enforcement actions, China has moved against a number of international companies in industries ranging from pharmaceuticals, cement and jewelry to software, milk and auto manufacturers.

Automakers including Audi, Daimler, BMW and Tata have begun dropping prices on parts in response to the actions, and many face substantial fines as well. Many other companies in a broad sampling of sectors are either figuratively holding their breath, waiting for the ax to fall, or protesting to their home countries what they see as targeted treatment of foreign firms. Synchronized raids of multinational corporate offices in China have resulted in data downloads, confiscations and admonitions not to seek legal representation or protest against judgments of illegal behavior.

While Beijing denies that ex-China companies are the ones primarily under the lens, offering examples of domestic firms that have also felt the sting of the enforcement lash, others aren’t so sure. A year ago an investigation directed at companies that sell milk powder for infants resulted in six companies being fined a total of $109 million. Accused of price fixing and anticompetitive behavior, five of the companies were from outside China, including U.S.-based Mead Johnson Nutrition, while the sixth company was headquartered in Hong Kong.

The European Union’s Chamber of Commerce, in fact, has expressed concerns over the increasingly high-profile investigations, saying in a statement, “While the European Chamber recognizes that a number of Chinese companies have been investigated for AML [antimonopoly law] violations, the European business community is also increasingly considering the question of whether foreign companies are being disproportionately targeted in the investigations.”

Investors might be getting a little worried, too, as enforcement intensifies, cutting company profits and imposing fines in the millions of dollars.

Not just the EU’s Chamber of Commerce, but the Chamber in the U.S. as well are hoping to convince China to back off from what they see as one-sided approaches to bolstering home industries, rather than supporting a stronger rule of law.

John Blank, chief equity strategist at Zacks, said that outside pressure on China to change how it goes about investigating companies for what it sees as monopolistic or price-fixing behaviors is unlikely to succeed. He pointed out that China has had plenty of time to decide how it will handle the issue since passing the AML in 2008.

Instead of putting it into practice immediately, he said, they studied how Europe and the U.S. tackled the problem, with a single agency—then decided to follow a different path. Three different agencies deal with antitrust in China: the Ministry of Commerce (MOFCOM), which deals with mergers; the State Administration for Industry and Commerce (SAIC), which handles nonprice-, nonmerger-related issues (such as software bundling); and the National Development Reform Commission (NDRC), which handles price issues (such as price fixing and retail pricing).

The three different agencies look at both vertical and horizontal issues, Blank said.With the auto industry, they’re focusing on vertical integration, such as from parts suppliers, and have attacked the car companies’ methods of pricing for replacement parts.

According to the Insurance Association of China and the China Auto Maintenance and Repair Association, buying all the parts that make up a Mercedes C-Class sedan would cost 12 times as much as the cost of a whole new car—and that’s something the AML agencies are taking a hard look at.

While it’s true that part of the reason for the high price of auto parts, and even the cars themselves, is thanks to a collection of taxes that include a value-added tax of 17%, an import tax of 25% and a consumption tax that can run as high as 40% based on engine displacement, that’s not what the agencies are examining. Instead, they’re considering other contributing factors. One of those is how much China contributes to a multinational company’s bottom line. If, in their judgment, it’s too high, that’s a good enough reason to investigate.

Blank said that in a lot of cases the Chinese agencies are right on things like “tying and bundling ... it’s been done in the U.S. and Europe for a long time. You pay double for a special oil [from the dealer for your car]; it’s not okay, you just have to do it, but [the Chinese] are saying no, they don’t want that.”

Blank added, “They’re rational people and don’t want to blow up investment, trade, technology, and the rest. But they don’t want to be exploited and they want to stay in control. A lot of the bleeding and whining [from companies] is understandable, but at the end of the day a lot of the practices are not all that cool from a monopoly perspective ... Having three agencies go at you is a lot, but that’s the message.”

While EU companies and countries that want to protest will likely have to go through the WTO, “the problem is that nobody wants to upset the applecart [of trade with China] ... as long as China stays with parts and mergers that are obviously wrong, [there may not be all that much that the EU] will do.”

The EU’s Chamber is, however, trying to push for more transparency in China’s AML process. In its statement, it said, “The European Chamber has received numerous alarming anecdotal accounts from a number of sectors that administrative intimidation tactics are being used to impel companies to accept punishments and remedies without full hearings. Practices such as informing companies not to challenge the investigations, bring lawyers to hearings or involve their respective governments or chambers of commerce are contrary to best practices.”

However it plays out, Blank said the current enforcement flurry will be hardest on smaller businesses. “The little guys aren’t going to be able to play in these markets as easily any more. Whenever you put litigation [into the picture], it’s more obstacles for the little guy, more multinational attorneys, and [it’s the big] multinational companies that can afford them,” he said.

He cited Qualcomm as an example. The company has been under investigation for possible antitrust violations relating to patent licensing and smartphone chip pricing, and most recently a member of the NDRC was dismissed from his post after he was accused of accepting payments from Qualcomm and cowriting a report for the company on how it priced its licenses. “[Qualcomm is] big and strong,” said Blank. “But that’s the kind of thing that’s going to happen” if China continues on its current course.

Still, with the lure of such a large market, companies will find themselves adapting in one way or another, and China is likely counting on that.

While the AML actions are a “clear negative for big companies, a big hit for U.S. and small companies, and ambiguous as to whether it has any benefit,” the bigger risk is the Chinese market itself. “As an investor you buy Chinese stocks, U.S. and EU stocks with big positions in China revenue-wise.... That’s a different set of problems; securities issues are far more important than any trust issue.”

Blank warned that “massive shorting, low volume, the moratorium on IPOs and corruption all poison things as far as China stocks are concerned. Taxes and antitrust [problems are] in the second rank, and the first rank is the actual maintenance of security markets themselves.”